This week saw the largest pullback all year in the S&P 500 Index. From its high of May 22 the index lost 5.2%. As corrections go, that one was quite mild.
Are we therefore out of the woods? No, that won’t happen until we retake and cross 1,687.93 on the S&P and 15,542 on the Dow. Until then, we are in no man’s land. That is just fine with me. I think we need a few more weeks of back and fill before the markets regain their footing.
The main cause of concern, investor fears that the Fed will begin to taper levels of stimulus, seem to have been alleviated on Friday (for now) by the non-farm payroll employment number. America added 175,000 jobs in May. That fit within my Goldilocks thesis, which says that as long as the data is neither too good nor too bad, the Fed will continue to stimulate via its bond purchases at its present rate of $85 billion/month.
Although the Fed’s next move is on everyone’s mind, it isn’t the only issue that concerns the market. Japan has become an important factor as well. Most readers are aware that I have been bullish on Japan since June, 2011 when the Nikkei Index was around the 9,350 level. Since then, that stock market has risen 70% to a high of 15,942 last month (not counting currency depreciation),
However, both the U.S. and Japanese markets began to decline on the same day in May. It was the day (May 22) that the markets found out that the Fed was thinking of “tapering” their bond buying program. Since then the Nikkei dropped 20% while the yen strengthened from 103/$1.00 to 95/$1.00. Those are BIG moves.
Many U.S. investors feared that our markets could drop just as quickly. That made little sense. Japan’s market had a massive rally, far larger than our own, in a short period of time. By whatever metric you use, the Japanese market had gotten ahead of itself and was in need of a fairly stiff correction. Now we have had it. I believe the downside risk from here is minimal, possibly another 2-3% at most in the Japanese market. The yen, however, could decline further to as high as 90/$1.00 before resuming its decline over the next month or so.
This gives investors a wonderful opportunity to invest in Japan for the long term before the next phase of market appreciation occurs. This next leg will occur sometime after the Japanese Upper House elections in July. Until then, I expect to hear an increasingly bearish chorus of criticism similar to the doubts expressed in the early days of our own Fed stimulus program. The Central Bank of Japan’s efforts to grow their economy through devaluing the currency while pumping trillions of yen into their financial markets will work, in my opinion.
But there is more. Markets were underwhelmed this week with Prime Minister Shinzo Abe’s economic package of structural reforms. Those reforms are considered the third and most important arrow in Abenomic’s quiver (with monetary and fiscal stimulus arrows one and two). Personally, I believe real structural reform, an extremely daunting task, will require a consensus of both Upper and Lower Houses of the Japanese Parliament.
That is why July’s Upper House election is a crucial win for Abe. I am betting his allies win that election. In which case, changes in the structure of Japan’s decades long log jam of labor and corporate practices will finally be broken. Until then, have some patience and don’t expect much from the Japanese market. As for our market, use any dips to add to positions. I think the upside ahead is worth the wait.